Abstract The purpose of this paper is to document empirically the effect of firm growt

Azim Aslani

Beigbaghlu

Ghahramani Latif

Nasrin Khodabakhshi

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International Journal of Accounting Research       Vol. 1, No. 10, 2014 
1 
 
THE EFFECT OF FIRM GROWTH OPPORTUNITIES AND EARNINGS 
PERMANENCE ON THE FREE CASH FLOW RETURNS AT 
PETROLEUM INDUSTRY IN IRAN 
 
 
 
Latif Ghahramani Beigbaghlu 
Department of Accounting, Germi Branch, Islamic Azad University, Germi, Iran 
Azim Aslani  
Department of Accounting, Astara Branch, Islamic Azad University, Astara, Iran 
Nasrin Khodabakhshi  
Department of Management, Khalkhal Branch, Islamic Azad University, Khalkhal, Iran 
 
 
 
 
Abstract 
The purpose of this paper is to document empirically the effect of firm growth 
opportunities and earnings permanence on the free cash flow returns. The 
population of this study are the companies that active in Petroleum industry in Iran 
since 2007 and had this characteristics: (1) Fiscal year is end March 19, (2) During 
the years 2007 to 2013 be presented annual Audited financial statements (3) 
Companies has accepted in Tehran stoke Exchange since 2006 and (4) Final sample 
from 2007 to 2013.  With considering this situation, 47 companies were selected as 
sample. The sampling method of this study is probability - simple random sampling. 
Data has gathered from www.rdis.ir and www.irbourse.com. In order to analyze the 
data, we used deductive and descriptive statistical methods. The results K-S Test 
shows the test distribution is Normal. So we can use Multi Regression to test the 
hypothesis of the research. The  findings show that growth opportunities has impact 
on free cash flow returns and earnings permanence has not impact on free cash flow 
returns. 
Keywords: growth opportunities, earnings permanence, free cash flow returns 
 
 
 
INTRODUCTION  
The changing face of globalization will present new challenges for companies in the coming 
years. As Iran manufacturers face an increasingly competitive global business environment, they 
seek out opportunities to reduce production costs without negatively affecting product yield or 
quality. Uncertain energy prices in today’s market place negatively affect predictable earnings, 
which are a concern, particularly for the publicly traded companies in the petrochemical 
industry. Improving energy efficiency reduces the bottom line of any petrochemical plant. For 
public and private companies alike, increasing energy prices are driving up costs and decreasing 
their value added. Successful, cost-effective investment into energy efficient technologies and 
International Journal of Accounting Research       Vol. 1, No. 10, 2014 
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practices meets the challenge of maintaining the output of a high quality product despite reduced 
production costs. This is especially important, as energy-efficient technologies often include 
“additional” benefits, such as increasing the productivity of the company and reducing the 
emission of greenhouse gases. 
Energy use is also a major source of emissions in the petrochemical industry making energy-
efficiency improvement an attractive opportunity to reduce emissions and operating costs. Iran is 
an energy superpower and the Petroleum industry in Iran plays an important part in it (SHANA 
(2010; Balamir, 2009). In 2004 Iran produced 5.1 percent of the world’s total crude oil (3.9 
million barrels (620,000 m3) per day), which generated revenues of US$25 billion to US$30 
billion and was the country’s primary source of foreign currency (Ministry Of Commerce, 2009). 
At 2006 levels of production, oil proceeds represented about 18.7 percent of gross domestic 
product (GDP). However, the importance of the hydrocarbon sector to Iran’s economy has been 
far greater. The oil and gas industry has been the engine of economic growth, directly affecting 
public development projects, the government’s annual budget, and most foreign exchange 
sources (Glenn and Hooglund, 2010). 
Share prices can be decomposed into two elements - the value of "assets-in-place" and the value 
of growth opportunities. This distinction is central to the valuation of corporate equity (e.g. 
Miller and Modigliani, 1961), corporate financial structure (Myers, 1977), corporate cost of 
capital and capital budgeting decisions (Myers and Turnbull, 1977, and Majd and Pindyck, 
1987).  
Despite the importance of growth opportunities (also known as growth options), relatively little 
work has been done on how to identify the proportion of company value accounted for by the 
value of growth opportunities. Kester (1984) and Brealey and Myers (1981) developed a model 
(subsequently referred to as the KBM model) for separating the overall market value of a 
company into the value of assets-in-place and the value of growth opportunities. Kester (1984, 
1986) and Brealey and Myers (1996) have demonstrated this decomposition for very small 
samples ofmajor US corporations at a single point in time. Based on a sample of 15 companies, 
Kester (1984) argue that the present value of growth opportunities (PVGO) on average accounts 
for more than 50% of company market values. In his 1986 paper (based on a total sample of 9 
companies split between industries), Kester find PVGO to account for approximately 56 percent 
of total market value for electronics companies, 43 percent for chemicals companies, and 48 
percent for paper companies. Similarly, Brealey and Myers (1996 p. 71) find that, for their set of 
5 "income" stocks, PVGO accounts, on average, for 34% of total market value. For the 5 
“growth” stocks, PVGO accounts for approximately 66% of the total market values.  
Miller and Modigliani (1961) split firm value into:  
• the present value of the uniform, perpetual earnings on assets currently held, and  
• the present value of the opportunities that the firm offers for making additional 
investments in real assets that will yield more than the "normal" (market) rate of return.  
Both present value calculations are made using the same" cost of capital" discount rate.  
Myers (1977) records the distinction as between:  
• assets that can be regarded as call options to purchase real assets where ultimate value 
depends on further discretionary investment by the firm, and  
• real assets with a market value which does not depend on further discretionary 
investment.  
Myers notes specifically that maintenance of plant and equipment is a discretionary investment 
and that the continuance of the firm's current activities is therefore discretionary. Real options 
International Journal of Accounting Research       Vol. 1, No. 10, 2014 
3 
 
are not simply associated with potential growth. Despite this tangential comment, the distinction 
used throughout most of his paper is that between growth opportunities and the market value of 
cash flows from assets-in-place.  
Firms envisioning future growth opportunities to finance future growth opportunities, with the 
expectation of generating future abnormal profits. However, in the real world, firms don’t enjoy 
this luxury because of the presence of capital market imperfections like information asymmetry 
and transaction costs that force corporate managers to rely on internally generated funds for 
investing in growth opportunities (Chung et al. 2005). 
While the persistence of earnings is unlikely to be a complete definition of earnings quality, it is 
considered to be an important qualitative characteristic of earnings. Lipe (1990) considers 
earnings persistence as the degree to which the current period’s innovation becomes a permanent 
part of the earnings stream. Earnings that are more persistent are more predictable and enjoy a 
market premium (Francis et al. 2004) and, therefore, should be more strongly associated with 
contemporaneous stock returns compared to earnings that are transitory. Because transitory 
earnings are valuation irrelevant, investors shift their focus from such transitory earnings to some 
other valuation matrix, g., FCF, as an input into the equity valuation model.  
Penman and Yehuda (2009) examine the market valuation of FCF using accrual-based valuation 
principles. They reveal that earnings are priced positively as expected but, given earnings, FCF 
does not have any explanatory power for stock returns. This latter finding contradicts the 
findings from a substantial volume of research documenting that cash flow from operations does 
have relative and incremental explanatory power, vis-à-vis earnings, for explaining stock returns. 
However, they reconcile the findings by noting that, “...accrual accounting operates in a way that 
recognizes Miller and Modigliani (1961) notion of dividend displacement and ...dividend 
irrelevance...free cash flow,...is a dividend from the firm that reduces the value of the firm but 
does not affect the cum-dividend value of the firm” (pp. 454-55). The purpose of this paper is to 
document empirically the effect of firm growth opportunities and earnings quality on the market 
valuation of free cash flow.  
 
METHOD 
The population of this study are the companies that active in Petroleum industry in Iran since 
2007 and had this characteristics: 
- Fiscal year is end March 19 
- During the years 2007 to 2013 be presented annual Audited financial statements. 
- Companies has accepted in Tehran stoke Exchange since 2006. 
- Final sample from 2007 to 2013  
So, with considering this situation, 43 companies were selected as sample.The sampling method 
of this study is probability - simple random sampling. Data has gathered from www.rdis.ir and 
www.irbourse.com. 
In order to analyze the data, we used deductive and descriptive statistical methods. The results 
K-S Test shows the test distribution is Normal. So we can use Multi Regression to test the 
hypothesis of the research. The SPSS tool has been used.  
 
 
 
 
 
International Journal of Accounting Research       Vol. 1, No. 10, 2014 
4 
 
RESULTS AND CONCLUSION  
A) Deductive Results  
Table 1 to shows the deductive results of variables in Petroleum industry. 
FCFY EP GO SIZE LEV  
47 47 47 47 47 n 
.3783 .3921 1.9252 5.8831 .6033 Average 
.2780 .3300 1.7690 5.6770 .5780 Mean 
.35 .51 .72 6.81 .27 Mode 
.29719 .25943 .82252 .76754 .43893 Standard deviation 
.088 .067 .677 .589 .193 Variation  
2.004 .462 .876 .064 4.048 Skewness 
4.200 -1.022 .393 -1.294 22.084 Elongation 
.10 .01 .72 4.33 .16 Minimum 
1.51 .88 4.25 7.02 3.08 Maximum 
17.78 18.43 90.48 276.50 28.35 Total 
 
B) Hypotheses Results 
In this paper we have two main hypotheses. The statistical way of analysis of hypotheses is two 
ways, H1 is acceptance of hypothesis and H0 is rejecting of hypothesis. In other words, it means 
that H1 has positive meaning and H0 has no meaning.  
First hypothesis: Growth opportunities has impact on free cash flow returns 
- H1: Growth opportunities has impact on free cash flow returns 
- H0: Growth opportunities has not impact on free cash flow returns 
Table 2 shows that Multi Regression analysis has been done in order to determine the effect of 
Growth opportunities as independent variable and free cash flow returns as dependent variable.  
 
= + 	 × + × + 	 × +  
 
Table2, Coefficient of Determination and Durbin Watson 
Durbin 
Watson 
Adjusted Coefficient 
Of Determination  
Coefficient Of 
Determination   
2.306 .410 .448 Growth opportunities and 
free cash flow returns 
Table 2 results show that the test distribution is normal, Because Durbin Watson test is 2.306 and 
is Between 1.5 – 2.5. So, we can used liner Regression.  
Table 3 shows the ANOVA results. 
 Square df Mean 
square 
F Sig 
Regression 34.423  3 11.474 11.653 .000 
Difference 42.340  43 .985   
Total 76.763  46    
 
Table3, Multi Regression of the independent and dependent variables 
International Journal of Accounting Research       Vol. 1, No. 10, 2014 
5 
 
sig t BETA SE B Explanatory variable 
.004 3.016  1.303 3.931  constant 
.000 5.471 .623 .179 .978 GO 
.014 -2.571 -.310 .203 -.522 SIZE 
.109 -1.637 -.197 .354 -.579 LEV 
 According to the table, it is observed that the amount of sig is equal 0.000 at 99% confidence 
level is less than 1%. Therefore, assuming a linear regression model was significant and the 
model is confirmed. We can say that Growth opportunities has impact on free cash flow returns. 
 
Second hypothesis: Earnings Permanence has impact on free cash flow returns 
- H1: Earnings Permanence has impact on free cash flow returns 
- H0: Earnings Permanence has not impact on free cash flow returns 
Table 2 shows that Multi Regression analysis has been done in order to determine the effect of 
Earnings Permanence as independent variable and free cash flow as dependent variable.  
= + 	 × + × + 	 × +  
Table2, Coefficient of Determination and Durbin Watson 
Durbin 
Watson 
Adjusted Coefficient 
Of Determination  
Coefficient Of 
Determination   
2.152 .062 .123 Earnings Permanence and 
free cash flow returns 
Table 2 results show that the test distribution is normal, Because Durbin Watson test is 2.152 and 
is Between 1.5 – 2.5. So, we can used liner Regression.  
Table 3 shows the ANOVA results. 
 Square df Mean 
square 
F Sig  
Regression 9.442 3 3.147 2.010 .127 
Difference 67.321 43 1.566   
Total 76.763 46    
Table3, Multi Regression of the independent and dependent variables 
sig t BETA SE B Explanatory variable 
.003 3.121  1.620 5.057 constant 
.097 -1.695 -.248 .729 -1.235 EP 
.214 -1.260 -.194 .260 -.327 SIZE 
.357 -.932 -.143 .452 -.422 LEV 
According to the table, it is observed that the amount of sig is equal 0.097 at 99% confidence 
level is less than 1%. Therefore, assuming a linear regression model was significant and the 
model is confirmed. But Earnings Permanence has not impact on free cash flow returns. 
 
References  
1. Balamir C., B., (Winter 2009), Global Energy Geopolitics and Iran, Uluslararası lişkiler, 
Volume5, No 20p. 179-201 
2. Brealey, R.A., and Myers, S.C. (1981) Principles of Corporate Finance, (1stEdition), 
McGraw-Hill.  
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McGraw-Hill.  
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4. Chung, R, Firth, M & Kim, Jeong-Bon 2005, ‘Earnings management, surplus free cash 
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THE EFFECT OF FIRM GROWTH OPPORTUNITIES AND EARNINGS PERMANENCE ON THE FREE CASH FLOW RETURNS AT PETROLEUM INDUSTRY IN IRAN

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THE EFFECT OF FIRM GROWTH OPPORTUNITIES AND EARNINGS PERMANENCE ON THE FREE CASH FLOW RETURNS AT PETROLEUM INDUSTRY IN IRAN

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